Implied Volatility is the volatility derived from an option with a known price (or premium). If the price of an option is known, the other inputs (such as spot, strike, time etc) can be either taken from the option contract or market data sources, thus the only remaining unknown input – the volatility can be solved for. The Black Scholes option pricing formula cannot be reversed to express volatility in terms of other inputs so an iterative approach is required by testing different volatilities.
Typically exchange traded options prices are used for deriving implied option volatilities.
Derivatives ONE features an implied volatility calculator based on the Newton Raphson iterative method of calculating implied volatility.
Firstly, enter the option details including the option premium (ie the option price or value):
The system will them output the annualized volatility based on the option inputs:
You can test this value by using it in the European Option calculator to determine the option price.
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